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Be the Millionaire Next Door

Ed McMahon was right. It really could happen to you -- with a little effort.

We don't advocate greed at Motley Fool Hidden Gems. But we also know you're not averse to becoming financially independent. In this article, I aim to show you our road map to becoming a millionaire.

Our search for the best small companies in the world is about both financial reward and investment mastery. Over the more than five years we've been opining on stocks, we've worked though market booms and market busts. In fact, we started in the middle of the biggest bust in decades ... except, well, this one. And through it all, we've beaten the S&P 500's returns by more than 5 percentage points since inception in 2003.

That's five points' worth of extra profits when things are good, and five points less pain than everyone else is feeling when things are bad. How do we keep beating up on the market? How can you do it? By thoroughly researching small-cap stocks and picking only the best of the best, individual investors can make millions -- over time.

Why small caps in particular?These stocks are truly neglected by the large institutional investors that own the vast majority of the S&P 500. And that's good news for us.

If you haven't researched a small business like Hercules Offshore(NASDAQ:HERO), MDC Holdings(NYSE:MDC), or American Oriental Bioengineering(NYSE:AOB), well, you're missing some of the great companies of tomorrow. We encourage you to look into them at your own pace. But in order to really win with these investments, you have to understand the precepts that have created extreme wealth and erased financial concerns for average people like Theodore Johnson, Hetty Green, Peter Lynch, and Anne Scheiber. You must learn to emulate their behavior.

In our opinion, it all starts by being a patient, long-term owner of high-quality, low-profile, small companies. Every one of those qualifications counts:

patient

long-term

owner of

high-quality

low-profile

small companies

Tap those ruby-red slippers and say that 10 times quickly.

As you master these precepts with us, some of you will earn millionaire status in as little as 12 years. For others, it may take 25 or 30. What's important, though, is that you mix a formula for non-temporary success. We're here to help you make that happen.

Learn from Shelby Davis' dynastyOur dual roles are to teach you the principles and then do the research heavy lifting for you. We want to relieve you of the necessity of sorting through the nearly 5,000 small-cap stocks trading on the U.S. stock markets to find the very best -- companies like Dell(NASDAQ:DELL) and Wal-Mart(NYSE:WMT), both of which grew from relative obscurity. Dell started as a computer direct-seller that raised just $30 million for its 1988 IPO. Wal-Mart began with one store in Rogers, Ark. They've become $17 billion and $188 billion companies, respectively, and they made their owners millionaires many times over. But finding the greatest small companies is only half the battle.

The other half is captured beautifully in the investment career of Shelby Davis Sr., featured in John Rothchild's book The Davis Dynasty. Davis formed a philosophy that helped him turn a $50,000 account into $900 million over his lifetime. How? By constantly buying new stocks and rarely selling any. For example, he bought into Chubb(NYSE:CB) very early and rode it to simply unbelievable returns.

Davis treated investing and ownership like a game -- a very serious game, mind you, but a game nonetheless. He stayed within his areas of expertise, didn't worry about whether the market was overvalued or undervalued from one year to the next, and methodically saved and invested new money each month.

That's your commitment -- to save and invest perpetually. Our commitment is to try to earn you something on the order of 15% yearly returns (with very low transaction costs and most taxes deferred for a minimum of three to five years). What follows are examples of how Hidden Gems can help four different investors, of different ages and financial means, and earning different levels of income, to make a million bucks. Chances are, one of these will be right for you.

Scenario 1: Start with $350 and add $350 in new savings each month. Do so for 25 years. You will end up with $1 million.So you're fresh out of college and just starting your first job as a cubicle vassal in the big city? Dreams of millionairedom seem as "pipe" to you as the canned air you breathe Monday through Friday. But never fear, young capitalist. Take your present savings, what's left from Grandma's graduation gift, and every month, put away just 17.5% of your monthly $2,000 paycheck. In 25 years -- and my, how they'll fly -- you'll be able to afford that house on the hill.

Scenario 2: Start with $30,000. Add $350 per month for 20 years.Thirty thousand dollars is a great place to start. You can slash five years off your timeline while investing no more every month than our recent college graduate. Just think: You put $350 a month into your retirement fund, and you'll likely be a millionaire long before you've even paid off that mortgage.

Scenario 3: Start with $100,000. Add $225 per month for 15 years.Now we're talking. You're already 10% of the way to millionairehood, my friend. Just 90% to go and you're set. How to do it? If you've managed to save up $100,000 already, putting away an extra $225 a month for the next 15 years should be a piece of cake. No pain, all gain. Shave five years off the 20-year plan because of your present circumstance. You're there in 15 years.

Scenario 4: Start with $150,000. Add $500 per month for 12 years.What?! You've already got $150,000 stashed away, but it's only earning 1% in a money market fund? Well, there's no need to be embarrassed. For one thing, you seem to have picked one of the banking crisis' survivors. And yes, wealth preservation has been the primary aim of history's greatest investors. But with retirement looming, you should earn at least a market rate of return. If you can stand the volatility of small caps, and can add $500 in new savings per month, we think you can get there in 12 years.

ConclusionIf you want to achieve your long-term goals, it starts with you being able to save money each month. We're aiming to achieve market-beating returns, meanwhile, and while we've based each of the above scenarios on a belief that we can earn about 15.5% per annum over long periods of time, you might be thinking 15.5% is pretty aggressive.

That's especially true in light of what the market's been doing lately. So heck, let's assume we're wrong and that markets won't rebound as strongly as we expect from this latest crash. Say we only earn you 10% yearly returns from this point on. Well, by regularly saving and investing, you'll still be a long way toward a million bucks.

The key, as we see it, is to gain complete financial independence and investment mastery by methodically saving and perpetually investing, by taking long-term ownership in sound small companies at attractive prices, and by rarely selling.

So do you want to become a millionaire or don't you? Take a gander atMotley Fool Hidden Gems for one month -- for free. If you like the service, sign on for a year or two, or for life. If not, cancel with no obligation. It's as simple, and as easy, as that.

This article was originally published on Dec. 1, 2004. It has been updated.

Fool contributor Rich Smith owns shares of American Oriental Bioengineering, which along with Hercules Offshore and MDC Holdings is a Hidden Gems recommendation. Wal-Mart and Dell are Inside Value selections. The Fool owns share of AOB. The Fool has adisclosure policy.

Author

I like things that go "boom." Sonic or otherwise, that means I tend to gravitate towards defense and aerospace stocks. But to tell the truth, over the course of a dozen years writing for The Motley Fool, I have covered -- and continue to cover -- everything from retailers to consumer goods stocks, and from tech to banks to insurers as well. Follow me on Twitter or Facebook for the most important developments in defense & aerospace news, and other great stories besides.